When searching to a purchase a home, there are various factors that determine the maximum loan you can afford. Two of the most important are mortgage interest rates and home prices. Is it better to look for lower priced homes or search for the lowest interest rate? Let's look into this more to come up with the right choice.

Connection Between Mortgage Rate/Home Price Most know that higher mortgage interest rates make it more expensive to buy a home, you may have been told that home prices tend to drop during times of high interest rates in order to offset those costs. Sorry to say, that is incorrect.

There have been many times since 1980 when interest rates have risen significantly (over 2% in a one-year period) and home prices still increased with a strong trend upward. As an example, in April 1999 mortgage interest rates on 30-year fixed rate loans averaged 6.92% but spiked up to 8.52% by May 2000. Over that same period home prices surged higher by 10.9%.

Historical data indicates that there is very little correlation between home prices and interest rates at all. Each of these components is influenced by the overall strength of the economy, more than each other. If the economy is flourishing, interest rates will probably rise to calm inflation. Because there are more home buyers with stable jobs and rising income, home prices will increase accordingly with the rate of inflation.

Comparison of Total Mortgage CostsKnowing when the right time is to buy is not an easy thing to do let alone a high demand market like the metros in California. Trying to time the market exactly is nearly impossible. It is best to buy a home when you can comfortably afford the payments, rather than waiting for the market to hit some magic number a guru mentioned.

To illustrate, say you decide to buy a $500,000 home when the average interest rate is 4.25%. If you bring in a twenty-percent down payment ($100,000), your monthly payments are $1,968 and your total mortgage costs throughout the term of the loan would be $708,393. However, you decide to wait it out a year and interest rates move up to 5.25% while the same house falls in value to $450,000.

This is excellent news. Now that 20-percent down payment is only $90,000 but your monthly payment would rise to $1,988. The total costs of the loan works out to be $715,656, $7,000 more than a year earlier and $20 more per month. Moreover, you'd also have a tax write-off for the mortgage interest if you had bought earlier.

It appears the interest rate has a bigger impact on your total costs. However, your down payment is less with a less expensive home and that can be a major factor for first-time buyers. If the down payment is very high due to the home price, some buyers will be priced out of the market and continue to rent.

Purchasing a home that is less expensive but has a higher interest rate could be worth it if you can refinance to a lower interest rate in the future. If you've found a great home you'll live in forever and the home price is reasonable it may be worth it paying for right now. If you're going to move within 10 years of buying like most homeowners, you may want that rate to be lower.

Your personal situation will help decide whether to search for the lowest home price or the lowest mortgage rate, . Let a licensed loan originator help figure out which one is better for you.